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Buying a Business

The idea of owning a business and being one’s own boss is appealing to many entrepreneurs, and when most people think of starting a business, they think of starting from scratch. However there is an alternative… Investing in an existing business that already has customers and cash flow can offer some advantages over starting a business from scratch.

If you’re thinking of going down this road there is a golden rule… “Buyer Beware”

Buying a business is like buying anything else – you must undertake careful investigation and research into the business to make sure you know what you are buying, why you are buying it and how much you should pay.

Here are some of the things you should consider:

Turnover – it is most important to ensure that the level of turnover or sales that the seller says the business is earning is factual. This can be checked by reference to sales records, daily takings books, cash register tapes and others.

Expenses – these can be determined from a careful review of financial statements. You should compare one period with another and investigate any differences or unusual trends.

Plant, machinery, equipment and vehicles – have a careful look at all the equipment, always ask for a schedule of the items you are buying (fully detailed) and check the value with someone who is experienced in the industry. You should also take into account the nature of the technology – will it date quickly and be superseded?

Inventory (trading stock) – this is always a major item. It is most important to have it valued the day you acquire the business by someone independent of the buyer and seller, who is experienced in the type of stock being valued. It is also very important that you attend the stock-take and make sure that the stock being sold to you is of good retail value or, alternatively, if it is old or obsolete, an appropriate reduction in price is made.

The market – is the market growing or does the company operate in a ‘mature’ market? What factors affect demand? Who is the competition? What is the degree of customer turnover? What is the sales volume of major customers? What are the channels of distribution? Are there any changing patterns in the distribution process?

Products and services – in addition to obtaining the expected product line information, you should be concerned with the rate of product liability claims. Does the company have adequate patent and trademark protection?

Premises – if you are buying land and buildings you must undertake the usual research and examination of title and premises that you would if you were buying your own house. You must check the zoning, district plan and all the other local body and regulatory requirements. If you are taking over a lease, you must have the lease carefully checked by your solicitor so that you know when the rent is due for review, who pays the rates, who pays the insurance and when the lease expires.

Goodwill – this is the thorny subject – sellers of businesses always think that goodwill exists – buyers don’t. Accountants are often asked what is the goodwill that applies to a particular business, and there are a variety of technical approaches that can be taken to calculate this. Your business adviser can assist you in determining the amount that you should pay for goodwill, and you should not buy a business without completing such a review. However, the fact remains that the best determinant of goodwill is the market place, i.e., what a seller will accept and what a buyer will pay. Many people buy businesses with an inflated goodwill value simply because the seller paid an amount a few years earlier and has added a bit onto it – the price very often does not relate to the earning ability of the assets. Take great care in considering the amount you pay for goodwill.

Financial Data – A buyer of a business should determine, or seek advice on:

What type of business am I interested in and how will I find it?

How much should I pay for a particular business?

How should the transaction be structured?

Will the new business meet my objectives?

Am I familiar with the company, industry and its products or services, its people and its facilities?

Management – If you are buying an existing business with existing staff, take a very careful look at the people you are employing. If key management or former owners are staying on as employees, how would the company be affected if they were to leave? To what extent does the company’s success depend on the people?

Reason for Sale – Always find out why the business is being sold (just as you always find out why a house is being sold). This is often difficult to determine but it is usually worth the trouble to find out the real reason.

Most Important, if the seller cannot provide you with the formal financial statements – BE CAREFUL. Do not rely on estimates or unsubstantiated profits. Check with your business adviser.